There’s little doubt that the real estate marketplace is in the midst of change. The huge price run-up seen during the past year or so is plainly cooling, interest rates have risen from the record lows seen in 2012 and higher prices may be causing some institutional investors to slow their purchases.

And yet, it’s very difficult to believe that investors will leave the real estate field in large numbers. To understand why just consider a new report released by Harvard’s Joint Center for Housing Studies: It suggests that “vacancy rates have begun to fall as the continuing foreclosure crisis and other forces dampen the allure of homeownership and help spur strong renter household growth.”

Translation: The combination of many would-be tenants — coupled with a limited rental stock — are driving rental rates higher, what can only be seen as good news for investors.

There are several factors leading to the new rental market. Much attention has been given to the $15 billion spent by six leading institutional investors, firms which have now acquired some 90,000 rental units. However, the rental marketplace continues to be dominated by small investors, the folks who own properties with one-to-four units.

“Individuals,” said the Harvard report, “own 55 percent of all rental units. They own more than 80 percent of rental units in properties with 1–4 units and about 70 percent of units in properties with 5–9 units. The remaining rental stock is owned by partnerships, corporations, limited liability companies, and nonprofit organizations.”

The truth is that the big firms on Wall Street represent a small slice of the real estate marketplace. The National Association of Realtors reports that existing home sales this year are likely to reach 4.49 million units with an average price in October of $199,500. That’s sales worth $896 billion just this year and the value of new home and condo sales are extra.

Suddenly, $15 billion doesn’t seem like so much.

Small Investors and Real Estate
There are three major reasons why small investors dominate the rental marketplace — and why their numbers may increase in 2014.

First, small rental units are an accessible investment. Not too many people have the financial clout to buy an apartment complex, but a house here and there is very plausible, especially with easy financing for properties with one-to-four units.

Second, you have to suspect that a lot of people became accidental investors after 2006 and 2007. They had homes, they wanted to move, but buyers were scarce so they converted the property into an investment unit. Or, they had a property, ran into financial trouble, and rather than a foreclosure or short sale they opted for the rental route. Now, several years later, they have benefited from rising rental rates, higher property values, and a certain comfort in their role as landlords.

“The foreclosure crisis and falling homeownership rate have led to a large volume of homes switching from owner to renter occupied,” says the Harvard Center. “The pace of net conversions from owner to renter tripled in 2005–7 relative to 2001–3 and then nearly doubled again in 2007–9 to 1.9 million units. Single-family detached homes were the driving force, accounting for three out of every four net conversions to rentals between 2007 and 2009.”

Third, personal tax benefits seem tougher and tougher to find, but owning investment real estate can take some of the sting out of April 15th. As a landlord you can generally deduct mortgage interest and property taxes, plus it’s possible to claim depreciation.

Changing Confidence”
“Housing market sentiment has clearly suffered in the wake of the recent government shutdown and debt ceiling debate,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “In October, we saw attitudes toward both the economy and the current buying environment experience their largest one-month drops in the survey’s three-year history.”

But while attitudes may shift up and down, people still want to live indoors. In practical terms they can buy, share or rent but given rising home values it appears that more and more of us are taking the rental route. Indeed, figures from the Census Bureau show that in the third quarter homeownership was down compared with 2012. The Census Bureau also found that vacancy rates were down and that the median asking rent for vacant units was $736, the highest on record.

What do these numbers say to investors? In many markets small-scale investors can get premium rents for competitive properties. While the number of foreclosures offered for purchase continues to decline, many units remain available — and they routinely sell at a discount. Combine discount pricing with rising tenant demand and 2014 looks like it will be an attractive year for investors in many markets — especially small-scale investors who are local and can manage their own properties.

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